Sunday, March 2, 2014

Residential construction weakness - looking beyond the cold weather

Recently we've had a visible slowdown in housing starts in the US, which has largely been attributed to the weather (see chart).

USA Today: - Housing starts fell sharply in January for the second straight month as cold and stormy weather continued to batter the recovering housing market.

Starts of single-family houses and apartments fell 16% to a seasonally adjusted annual rate of 880,000 last month after declining dramatically in December, the Commerce Department said Wednesday. Extreme winter weather is largely blamed for both poor showings after starts jumped to their highest level in a year in November.

But is there more to the sluggish construction data than freezing temperatures? If weather was the only factor, markets would be expecting a strong recovery in construction later in the year. But as this chart shows, weakness in July lumber futures points to rather subdued expectations for home construction this summer.

Some point to higher mortgage rates generating a drag on the overall housing market. The "taper-driven" spike in rates has definitely been unusually sharp, but mortgage rates have now stabilized below 4.5% - still quite low by historical standards.

To understand the non-weather factors of the sudden slump in private construction, we want to go back to one of the key sources of improvements in housing back in 2012. It was the boost in household formation (see post) that kick-started the housing market. Now, to many economists' surprise, the number of households has stopped growing in recent months - detracting materially from housing demand.

Source: US Census Bureau

To be sure, home construction should improve in the coming years simply because of demographics. Home building in the US simply hasn't kept up with population growth in recent years. But the big improvements will only take place once we see substantial gains in household formation.